Wynne Godley asks if Britain will have to withdraw from Europe

The implications for Britain of EEC membership are rapidly becoming so perversely disadvantageous that either a major change in existing arrangements must be made or we shall have, somehow, to withdraw.

I strongly support the idea of Britain’s membership of the Common Market for political and cultural reasons. I would also support co-ordinated economic policies which were mutually advantageous to all the member countries. But this is not what we have got at the moment. It has at last become well-known that the British Government is making net transfers of foreign exchange to the rest of the Community which will approach £1000 million this year and which are likely to rise further in 1980. To this figure must be added the £200 million or more which British consumers are handing over by paying prices for food imports from the EEC in excess of what they would otherwise have to pay.

The main purpose of this article is to describe two other adverse implications of membership which have not yet attracted attention. The first is that if sterling stays relatively strong, measures to limit expenditure from the Community Budget will cause a drastic fall in the income of British farmers. We would then be in the astonishing position of having to pay out vast sums of foreign exchange every year mainly to support the incomes of foreign farmers, while being simultaneously deprived of the power to protect the incomes of our own farmers.

The second point is that preliminary estimates can now be made of the so-called dynamic effects on British manufacturing of free trade within the Community which were always supposed to outweigh, in the long run, any ‘static’ costs. The indications are that the dynamic effects are large indeed, but unfortunately they are negative.

So we are all to be losers. The taxpayer through the Budget contribution, the consumer through higher food prices, the farmer through costs rising more than selling prices, and the manufacturer through rapidly rising import penetration.

I would now like to go over these points again in more detail. We have just been informed that the net contribution by the UK to the EEC Budget was £800 million in 1978, and it is reliably reported that in 1979 the net contribution will approach £1000 million and rise again next year. In addition, there have been outward transfers of foreign exchange from the UK to the rest of the EEC of around £200 million per annum from British consumers, because the prices they pay for food imported from the rest of the EEC are higher than on world markets. Taken all in all, the total net direct cost to the UK in terms of foreign-exchange transfers was probably around £1,100 million in 1978 and will, on present indications, rise towards £1,500 million in 1980.

Net payments by the UK are, of course, net receipts by the rest of the Community taken as a whole. The reason why the UK is a net payer on this scale is, in essence, easy to explain. Contributions to the EEC Budget, like tax payments into any national or federal Budget, are made broadly in accordance with ability to pay as measured by the total income of the contributor. However, unlike a national or genuinely federal system, transfers out of the EEC Budget to member countries have no equalising properties such as would be the case if they were used to provide a uniform standard for some public service – say, education or health – throughout every region. This is because three-quarters of EEC Budget outlays simply go to support agriculture. So those countries which produce more food than they need become net receivers, those which produce less are net payers. But this set of arrangements has no rationale in equity or economics; the pattern of inter-country transfers is the result of the implementation of certain arbitrary rules. And this pattern, as it turns out, is highly anomalous because two of the three poorest countries in the Community – the UK and Italy – are also two of the largest net contributors. The anomalous character of the arrangements is compounded by the fact that farm prices are supported at levels which generate large and growing stocks of food and wine which, in the end, will be either destroyed or sold at knockdown prices outside the Community.

Our Government is quite rightly making all kinds of minatory noises about the situation. It is hinting that an altogether different system should be introduced which would relate net payments or receipts to the ability of countries to pay, although it is difficult to see how this could be achieved without a very radical reform of the existing system of transfers which would necessarily be contrary to the interests of other members taken together. The Government also appears to be trying to hold down farm prices to a level which will reduce the cost of the Common Agricultural Policy both directly and by reducing the volume of farm output. But even if it succeeds in doing this it will alter only the scale, not the pattern, of net payers and receivers.

In the past few months, however, there has been a most important new development which may drastically alter the balance of opinion in Britain and which I do not think has yet been generally understood. This is the substantial appreciation of sterling vis-à-vis the currencies of other European countries as a direct result of the new Government’s general economic policy.

As long as sterling was weak it was possible for the Government successfully to oppose a general increase in farm prices within the Community and simultaneously to obtain an increase in prices for British farmers by devaluing the green pound. And this is indeed what happened in the first half of 1979. The general increase in farm prices throughout the Community since April 1979 has been about 5 per cent on average, but because of green-pound devaluations British farm prices, both to consumers and to producers of the relevant products, rose about 12 per cent in this period.

But strong sterling would make it impossible for the UK to have it both ways. Green currencies may only be devalued or revalued towards, never away from, par. Sterling recently reached a level which brought our green pound to within 1 or 2 per cent of par, therefore no significant further devaluation of the green pound was possible under existing rules of the CAP. In other words, British farm prices can only from now on rise at about the same rate as European prices in general unless or until sterling depreciates.

Should sterling be strong next year, a deep conflict will rapidly emerge. If EEC farm prices are raised significantly, net transfers from the UK to the EEC will rise even faster than is at present foreseen. If EEC prices are not raised, British farmers will have their real income substantially and progressively squeezed between the relative stability of prices which they will receive and the increase in the cost of labour, fuel and other materials, which looks like being at least 15 per cent during this financial year alone.

In sum, because of an arbitrary set of rules the UK is to make huge foreign-exchange transfers to countries richer (on average) than ourselves. The transfers we make relieve the taxpayers of predominantly agricultural countries – particularly France, Ireland and Denmark – in their support of their own farmers’ incomes. Our Government is obliged by arbitrary rules to make these contributions at a time when it is frantically cutting down expenditure on social services in our own country – including services to help the very young, the very old and the ill. And at the same time the Community rules to which we are at present committed are such (assuming sterling remains strong) that our own farming industry could be driven into a progressive depression, for we have lost the power, under those rules, to support our own farm incomes directly.

The time is just coming round for a preliminary evaluation of the scale and direction of any dynamic effects on British manufacturing industry of having a ‘home market’ with a population of 250 million. While no final conclusion can be reached yet, there is no doubt at all that Lord Kaldor, who always maintained these effects would be adverse, has the best of the argument at this stage.[*] It is true that UK exports of manufactures to the EEC have increased during the last five years a little faster than could have been expected from any projection of previous trends. This favourable effect is, however, somewhat offset by a trend less favourable than previously in exports to the rest of the world, and totally expunged by a vastly increased trend in import penetration of the domestic market by manufactures from EEC countries, particularly Germany. A careful, if very uncertain, estimate is that our balance of trade in manufactures in 1977 was £4,500 million worse than it would have been had we not joined the Community. These effects have been dynamic, but negative.

To sum the whole thing up, if we were not members of the EEC we could avoid gratuitous transfers abroad, with a large direct benefit to the taxpayer. At the same time we would be free to support the incomes of our own farmers in a way that was appropriately related to their needs and those of the country. And if we may also take into account the dynamic effects, our balance of payments would be better by several thousand million pounds than it is at present. This would by itself have had a favourable effect on real national income and output, but, more important, it would have enabled the Government to pursue a less restrictive fiscal and monetary policy. According to preliminary estimates, the real national income could have been at least 10 per cent higher than at present and the rate of price inflation several points lower than if we had never joined the EEC.

[*] For a careful analysis see Fetherston, Moore and Rhodes in the forthcoming Cambridge Journal of Economics.